Inefficiency is caused by human emotion, says Peter Kaye, the manager of the Melchior North American Opportunities fund.
Behavioural finance, a field of finance that proposes psychology-based theories to explain stockmarket anomalies, is fundamental to Kaye’s selection process.
Behavioural finance assumes that the information structure and characteristics of the market systematically influence individuals’ investment decisions and market outcomes. And that is for the worse, says Kaye.
“We are all emotional,” he says. “But when investors get angry, they make wrong decisions. Therefore, we are looking for companies where sentiment is neutral or negative.”
The $77.5m (£56.1m) portfolio is overweight in healthcare (22.4%), consumer discretionaries (19.5%) and information technology (18.8%).
According to Kaye, much valuable information is hidden, such as the reasons and catalysts behind changes.
For example, Netflix, an online DVD rental service, makes up 2.78% of his portfolio. “[In Netflix’s] matrix we noticed some numbers had started to pick up – numbers that indicated that things were getting better than analysts had forecasted,” says Kaye. “However, the main factor was that earnings revisions had turned positive. The market had not respected the value of the share.”
By mid 2007, Netflix had underperformed for about two years and estimates were negative. However, Kaye was proved right. “Netflix is now becoming more successful,” he says.
Illumina, which develops technology and kits to be used in genetic research, is another of Kaye’s favourites, taking up 2.49% of the fund’s portfolio.
“Illumina is one of our top 10 holdings. It wasn’t terribly well known but had a staggering level of growth,” Kaye says.
“The economy is in a terrible state but some sub-sectors and small companies are doing very well. And our screening will help us to find them.”
He says some companies will continue to do well as their competitors struggle. That is why he bought Goldman Sachs at a time when the weakened banking system is cracking further. He says the firm is stronger than its competitors, who “are struggling much more”.
According to Morningstar, over the year to March 2, the fund fell by 25% against an average fall of 22% for its peer group, the Investment Management Association’s (IMA) North America sector. It ranks 57th out of 78 funds in the sector.
Melchior funds carry golden hopes